Is high inflation always bad?

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: Inflation targets are set by central banks worldwide to achieve stable and sustainable growth and the possibility of institutional quality affecting the inflationary effect on growth makes it essential to study the inflation-institution-growth relationship. This paper considers whether or not the relationship between inflation and growth is nonlinear in the shape of convexity and if it differs for different levels of institutional quality. A two-step system GMM approach is used on an unbalanced panel for a yearly regression with 160 countries from 2000 to 2018. The yearly regression is additionally divided into subsamples for low, medium, and high institutional quality. The same model is used for a regression with five-year averages with data covering 157 countries from 1995 to 2019. The results indicate a convex relationship, and institutional quality is estimated to be adversely correlated with the point of convexity when a convex relationship is observed. The implication is that inflation becomes less damaging to growth at a later stage than for countries with a low level of institutional quality. However, the results are not robust, and additional research is therefore needed to further determine the true nature of the relationship.

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